When governments institute tax or spending initiatives to change the course of their country’s economic condition, this is called fiscal policy. Fiscal policy usually refers to macroeconomic change, where a government reforms employment, shifts economic trajectories, impacts inflation, or influences aggregate demand for products.
Fiscal policy is a common reaction to rising inflation or other expansionary processes that lead to the use of fiscal stimulus. The premise that governments could stabilize these symptoms in business and regulate economies using spending is mostly attributed to the English economist, John Maynard Keynes.
History of Fiscal Policy
Fiscal policy was conceived partly as a solution to the Great Depression. Keynes rejected the assumption that an economic downturn would self-correct in the private sector using the Depression as a key example. His concepts created the foundation for the New Deal and began the United States’ journey towards increasing social welfare and public works spending that continues to this day in forms like inclusionary zoning and density bonuses in commercial real estate.
In addition to the Great Depression, the 2008 financial crisis was another instance where fiscal policy was used in the form of the American Recovery and Reinvestment Act, which funneled money into the economy to try and increase aggregate demand.
Fiscal Policy in Commercial Real Estate
Fiscal policy can have a far-reaching impact on commercial real estate investments due to its ability to affect interest rates for regular mortgages as well as short-term financing options like bridge loan interest rates. Real estate capitalization correlates directly to interest. What investors decide in the current market is largely dictated by their expectations for the market’s direction.
This means that when governments make sweeping changes to spending or tax rates, they impact local finance costs, housing demand, job creation, expenditures, and more. This is the infrastructure that guides prices, returns, interest, and inflation in the commercial real estate industry.
Downsides of Keynesian Fiscal Policy
Keynesian economics relies on government spending to enact fiscal change. During an economic slowdown or recession, the hope is that fiscal change can stimulate a nation’s economy by increasing demand, further preventing recessions.
However, expansionary policies have detractors. As the government spends more money to increase aggregate demand, private demand is displaced as the driving force behind the economic condition. This can lead to under or overcompensation as the nation’s prices and interest rates now depend on the quality of the fiscal policy. Overcompensating for economic recessions can lead to increasing debt as well as an increased risk of inflation.
Fiscal Policy’s Impacts are Hard to Predict
As emergency fiscal measures, these policies have been shown to “jumpstart” sluggish demand cycles. Over time, however, fiscal policies are difficult to predict since the money being moved cannot be moved instantly or distributed evenly.
In practice, fiscal policy relies on many variables, including how the industries and individuals funded by economic rearrangement react to their new wealth. Rather than uniformly improving the state of the country’s aggregate demand, Keynesian fiscal policy simply moves purchasing power from the previous recipients of wealth to new targets. What happens next is not always easy to predict.